July 2019 Update
Making the News
July was an eventful month, with negative sentiment on the local bourse (despite a rate cut of 0.25% by the SARB) and high volatility in global markets, particularly in the UK with a no-deal Brexit looming.
Locally, Eskom dominated the headlines together with rating agencies after Fitch Ratings left our international and domestic credit rating unchanged but revised the outlook, due to lower economic growth, down from stable to negative. This together with the very weak Q2 unemployment number of 29% (up from 27.5% in Q1) increased pessimism towards SA assets in July. Although expectations for economic growth in SA have reduced, some encouraging statistics were released from the construction sector stating that the estimated value of civil construction projects out to tender are up by +38.6% (Y/Y) in the second quarter.
A number of political events drove our local currency movements from abroad. The most significant event happened on the 23rd July in Britain, when Boris Johnston was elected as the UK Prime Minister. Days after his inauguration, he announced his intention for Britain to leave the EU in October with no deal yet in sight.
In the US, the economy remains robust, with second quarter GDP growing by +2.1% (Q/Q), annualised. This was above market expectations, and in part, explains why the Fed only cut rates by 0.25%.
Digesting the News
Overall, it is hard to argue against the concerns raised by Fitch. South Africa’s economic growth remains weak and is expected to be around 0.6% for 2019. Fiscal parameters deteriorated which included a large revenue shortfall as well as further funding needed to support the failing SOEs. Moody’s will share many of the same concerns highlighted by Fitch when they next review South Africa’s credit rating later in the year.
SA’s unemployment rate is the highest recorded since the current data series started and high by international standards. One reason for the latest jump in the unemployment rate was an increase in the number of discouraged workers, which rose by 115 000 over the past year. The higher unemployment rate reflects the poor state of the economy, which is fundamentally a result of the lack of fixed investment spending, as well as low business confidence.
Against this gloomy backdrop, it can be difficult to find positive news locally. However, there have been encouraging statistics released regarding the country’s investment into construction and water infrastructure. The majority of this steep rise in the civil construction projects was in road tenders which contributed 40% of the tenders, followed by water at 27%. Water projects have offered some opportunities over the last year, as this sector gained priority following the lack of infrastructure investment, particularly on maintenance, and the negative impact of the recent drought. Importantly, this was the first positive growth in the value of road projects since 2017, which should provide some relief and potentially some hope for the civil and construction industry looking forward.
In the US, the GDP performance in Q2 2019 was better than market expectations of 1.8% (according to Bloomberg). The key areas of strength in Q2 2019 were focused around consumer spending, especially household consumption on services such as healthcare, but also restaurants and hotels. A fairly wide range of US forward looking indicators have softened in recent months. This includes the ISM manufacturing index, the leading economic indicator and various confidence indices. This would suggest that despite the latest GDP growth rate the US economy is still expected to slow into 2020 resulting in a rate cut by the Fed in order help buoy the economy going forward.
In Britain, the hard-line Brexiteers seems to be standing behind Boris Johnson’s mission to make Britain the “greatest place on earth”. Similar characteristics as Mr Trump, the new Prime Minister of Britain stood confidently in front of assembled cameras to demand a loyalty oath to Brexit by 31 October, ‘do or die’, from the members of his ruthlessly selected government.
Markets in the Month
Following a strong rally during the second quarter, on the back of a potential US rate cut, the Rand faltered in July against the Dollar but remained stronger against the Pound driven by Brexit uncertainty. As a result, the Rand was 4% stronger than the Pound in July bringing its YTD appreciation to 6.3%. Over the last 12 months, the Rand is weaker against the Dollar and Euro while stronger than the Pound after the recent strengthening.
July was a tough month for the SA equity market (down -2.4%). Weak sentiment across the board was the primary reason investors steered away from SA risk assets to safer assets like gold or platinum. Despite the pull back, the ALSI still remains relatively strong in 2019 (up +9.5%) when compared to their EM counterparts which is up 7.6% YTD. Over the last year, the primary driver to our market was the Resource sector (+16.5%) return versus Financials and Industrials down -3.5% and -0.5% respectively over the period. The Resource sector benefit from a recovery in Platinum producers but also from strong returns generated by diversified miners such as Anglo American, which was up 115.2%.
SA Listed Property delivered -1.2% in July outperforming SA listed Equity. Most of the decline was driven by Brexit uncertainty with Hammerson and Intu down -25.6% and -37.7% respectively.
Local cash was the best asset class during the month outperforming local bonds by +1.7%. Key risks towards the fixed income asset class remain the credit rating agencies (Moody’s & Fitch) assessment of our sovereign rating, given that the debt burden will continue to grow as a number of State-Owned Enterprises apply for additional government funding and bailouts. Markets are looking at how Tito Mboweni and Pravin Gordhan manage the budget and the debt of the SOEs, with news expected on the progress made in both areas in the coming months.
Impact on Our Portfolios
The CWM multi asset strategies were down during the month because of the softer equity and listed property markets. On average the local models were down -0.4% in July. The CWM Income fund, which has no growth asset exposure and is used for short term investors, was positive in July.
A bias towards growth assets is essential for investors with a long-term time horizon in order to ensure outperformance of inflation over the long-term. Current projections for the next 5 to 10 years from growth assets are very attractive compared to inflation and are expected to be better than returns seen in the last 5 years.
5 Year Returns (p.a.) CWM Local Model Portfolios / Foreign Strategies
Given the recent recovery in growth assets in 2019, our models have participated in a reasonable amount of the upside ( up 3.6% on average so far in 2019). We are reasonably satisfied with the performance of the CWM portfolios versus peers over the last five years, despite the modest absolute returns shown above. Only CWM Retirement Growth and CWM Defensive have lagged their respective peer group averages over this period, largely dragged lower by above average exposure to the SA Listed Property sector.
Despite the Rand strength in the month, the performance of our Foreign Houseviews (HV) were good in Rand terms. YTD performance also remains robust, with Foreign Balanced and Equity generating +8.9% and +15.6% respectively.
We continue to encourage clients to assess performance throughout a full market cycle. With SA equity (+5.8% p.a.) and SA listed property (+5.6% p.a.) both delivering less than 1% above inflation (before fees) over the last five years, it is understandable why most SA based investors feel disheartened having endured an extended period of seeing their wealth struggle to grow in real terms.
When one looks at the 15-year average returns of local equity and listed property, patient investors have seen their wealth grow in excess of inflation by +9.7% and +11.2% per annum respectively, which importantly includes the last 5 years’ lacklustre return environment.
Globally, while Brexit remains a big concern for investors in UK sterling assets, we believe that a “no deal” exit from the EU could prove to be positive as it provides certainty to future plans in Britain despite the fears of chaos some critics expect. Moreover, the 0.25% rate cut in the US at the end of July will provide some comfort to EM assets such as SA given that the country tends to benefit from the perception of a weakening dollar due to their long-standing inverse correlation.
On the local front, the most unexpected news has been the poor unemployment result in the second quarter. Increasing employment has to be the number one economic/political/social objective, and can only be achieved through a concerted and sustained effort to improve skills development as well as encouraging private sector fixed investment spending, business development and entrepreneurship.
While we cannot control what happens globally, we believe that President Ramaphosa will make meaningful impact in turning our economy around. His state of the nation address may have been fairly well received, but it reinforced the perception that government is still ‘dreaming’ and needs to move from talking to doing, as Ramaphosa himself admitted. This will serve to restore trust and confidence in the economy and reignite the much-needed and sought after foreign direct investment (FDI) that will help to kick-start the economy.
Foreign Direct Investment into RSA: 2015 – 2018 (as % of GDP)
While continued investment in SA will support economic growth and job creation it is important to look at what has been happening in this respect. The graph above shows foreign direct investments (FDI) into South Africa as a percentage of total GDP in the calendar years 2015 to 2018.
A key take-away from the graph is the spike in FDI in 2018 which is just over 80% of the foreign investment inflow over the last 3 years preceding 2018. We believe this is indicative of the confidence foreigners have in our newly elected President and the expectation of turning our economy around. If this trend continues, and if government can stay on course with reforms, South Africa should be able to achieve better growth in the coming years.